Risk Management Report. Eik Banki P/F

Transcription

1 Risk Management Report Eik Banki P/F

2 2 Contents 1 Introduction Organisation Base capital Policy Base Capital Statement Solvency Objective and Policy Solvency Statement Individual Solvency Requirement Counterparty Risk Credit Risk Objectives and Risk Policies Authority and division of labour Credit Management and Control Credit granted by customer advisers and Branch Managers Collaterals Risk concentration Impairments Rating of customers Customers Circumstances that are considered when granting credit Actual Credit Risk Exposures Risk-weighted exposures and Capital Requirements Credit Risk and Risk of Dilution Defaulted and depreciated claims Financial collateral Market Risk Objective and Risk Policy Interest Rate Risk Equity Market Risk Foreign Exchange Risk Other price risks including Commodity Risk Reporting and Division of Responsibility Responsibility and monitoring Actual Market Risk Risk pertaining to the Trading Portfolio Exposures in equities that are not part of the Trading Portfolio Interest Rate Risk Liquidity Risk Objective and Policy Reporting and division of responsibility Responsibility and monitoring Operational Risk Objectives and Policy Reporting and division of responsibility Responsibility and monitoring Actual Operational Risk...21

3 3 1 Introduction Risk and risk management are an integral part of banking. The purpose of Eik Banki s risk management is to conduct operations in such a manner that it ensures that the Bank does not take on more risks than stipulated by the Board of Directors. The risk profile should support the Bank s business model. In the daily operations Eik Banki is exposed to the following risks: Credit risk, defined as the risk of financial loss arising when customers are unable to meet their financial obligations to Eik Banki. Market risk, defined as the risk that the market value of assets and liabilities, as well as off-balance items, will be affected as a result of changing market conditions. Eik Banki s market risk consists of interest rate risk, equity risk, foreign exchange risk and other price risks. Liquidity risk, defined as the risk that arises from differences in scheduled outgoing and incoming cash flow in the Bank. Operational risk, defined as the risk arising from inadequate and inefficient internal processes, human errors, IT-failures and external factors. In the risk report an assessment is made of solvency and individual solvency requirement. The difference between the two is as follows: Solvency is calculated in accordance with the Executive Order No. 510 of 25 May 2011 on Capital Adequacy, where all assets are assessed according to risk in separate risk groups. Individual solvency requirement is calculated using Eik Banki s risk profile, external factors and budget assumptions for the coming year, in addition to other factors, such as increased provisions for poor and non-performing customers. Each risk group will be analysed in the following sections in terms of objective, risk policy and actual risk exposure.

4 4 2 Organisation Board Nevnd of Directors Internal Audit Petur Anfinn Johannesen Management Súni Schwartz Jacobsen CEO Risk Management Sigmund Frederiksen Legal Department Høgni Høgnesen Executive secretariat Marjun Neshamar Human Resources Fanny Petersen Credit Jean Djurhuus IT & Development Sóleyð Hofgaard Finance Ole Guldborg Nielsen Corporate Olav Guttesen Retail Øssur Skeel Nolsøe Eik Markets Sverri Justinussen Sales, Communication & Marketing Ólavur Jensen Eik Banki s official organisational structure is illustrated above. General management and control of the above mentioned risks is centralised with organised reporting to the CEO and Board of Directors. Daily management, control and reporting are divided and carried out in different business units in the Bank. Risk Management monitors credit risk, market risk, liquidity risk, operational risk and IT- risk on behalf of the CEO. Risk monitoring is performed in accordance with the tasks of the Risk Management function as stipulated in the Danish Financial Business Act, section 71, and Executive Order No. 336 of 12 April 2012 for the Faroes on the governance and management of financial institutions etc.

5 5 3 Base capital This section describes the base capital including objective, policy and statement of base capital. 3.1 Policy The base capital is calculated in accordance with the Danish Financial Business Act in addition to guidelines on adequate base capital and solvency requirement for financial institutions (Vejledning om tilstrækkelig basiskapital og solvensbehov for kreditinstitutter) issued by the Danish Financial Supervisory Authority. 3.2 Base Capital Statement The table below shows the base capital statement as of 31 December Table 1: Base capital statement as of 31 December 2012 (DKK 1,000). Capital requirement Core capital before deductions 1,206,829 Proposed dividend 122,031 Intangible assets 1,408 Tax assets 12,935 Core capital after deductions 1,070,455 Share capital, not included in core capital 100,000 Capital base 1,170,455 4 Solvency This section describes how the solvency statement and sufficient capital are determined, in addition to the individual solvency requirement. The solvency is determined in accordance with the Executive Order on Capital Adequacy, where all assets are risk assessed in the separate risk categories. In addition to the solvency, the Bank is also required to determine the individual solvency requirement. This is to ensure that the Bank has sufficient capital to weather difficult periods and in order to meet the demands by the Danish Financial Supervisory Authority. The individual solvency requirement is calculated using the Bank s risk profile, social conditions and budget conditions for the coming year, in addition to other circumstances such as increased provisions for poor and non-performing exposures. 4.1 Objective and Policy Solvency Statement Solvency is calculated as core capital as a percentage of the risk-weighted assets. Core capital is determined in accordance with the requirements in chapter 10 of the Danish Financial Business Act, while the weighted assets are calculated in accordance with the Executive Order on Capital Adequacy. The risk-weighted assets are divided into three main categories: credit risk, market risk and operational risk. The table below shows the Bank s solvency statement.

6 6 Table 2: Solvency statement as of 31 December 2012 (DKK 1,000). Capital requirement Core capital before deductions 1,206,829 Proposed dividend 122,031 Intangible assets 1,408 Tax assets 12,935 Core capital after deductions 1,070,455 Share capital, not included in core capital 100,000 Capital base 1,170,455 Weighted assets Weighted assets not included in the trading portfolio including off balance-sheet items 3,997,954 Weighted items with market risk 449,7 Operational risk 577,036 Total weighted assets 5,024,690 Solvency ratio in accordance with FIL section 124, section 2, subsection % Core capital after deduction in % of weighted assets 21.3% Individual Solvency Requirement The calculation of the Bank s individual solvency requirement is based on a model developed by Lokale Pengeinstitutter and on guidelines on adequate base capital and solvency requirement for financial institutions issued by the Danish Financial Supervisory Authority. Through the use of the abovementioned model and the guidelines issued by the Danish Financial Supervisory Authority, the Management considers the Bank s calculated individual solvency requirement to be fair. The method applied by Eik Banki for its calculation of the individual solvency requirement reserves capital within four risk areas, credit risk, market risk, operational risk and other risks. The main purpose of calculating the individual solvency requirement is to determine the size of the base capital necessary to continue operations in the event of adverse developments in the Bank s operations. The variables and stress levels, which are to be tested, are determined on the basis of the Bank s current situation, the requirements specified in the Executive Order on Capital Adequacy and the guidelines on adequate base capital and solvency requirement for financial institutions. The purpose of the stress tests is to determine the Bank s strength by using the Bank s accounting figures and simulating the effects of a variety of negative events. The first part of the individual solvency requirement model is comprised of stress tests, where certain variables are used to stress the separate accounting entries from the latest financial statement.

7 7 Table 3: Stress tests in relation to determining the individual solvency requirement Table 4: Other risks in relation to determining the individual solvency requirement Stress variables Influence on variables Credit risk: Increase in impairments and provisions Market risk: Increase in interest rates Reduction in share price Reduction in exchange rate Counterpart risk on derivatives Real estate risk: Reduction in real estate prices Other risks: Reduction in income The Management decides which risks the Bank should be able to manage and which variables to stress test. The total impact on the individual solvency requirement is calculated by comparing the total impact of the result to the weighted accounting entries. In addition to the risk areas included in the stress tests, there are other risk areas which Eik Banki finds relevant to include in its assessment of the solvency requirement. These risks are listed in table 4. Additional capital to cover credit risk Including: Customers in financial difficulties Concentration risk of individual commitments Geographic concentration Commercial concentration risk Concentration of guarantees Additional capital to cover market risk Capital to cover operational risk Additional capital to cover other risks Including: Strategic risks Reputational risk Property risk Risk in relation to the size of the Bank Funding Liquidity risk Group risk Settlement risk Other circumstances The Management considers the risk factors included in the model as adequate to cover all risk areas, which the Bank s management is required by law to take into account, in determining the individual solvency requirement as well as the risks, which the Management finds that the Bank has assumed. In addition, the Board and Management must assess whether the base capital is adequate to support

8 8 future activities. In Eik Banki, this assessment is part of the general determination of the individual solvency requirement. An annual assessment is made to determine how expected growth affects the calculation of the solvency requirement. Stress factors are chosen based on Lokale Pengeinstitutter s model in addition to guidelines on adequate base capital and solvency requirement for financial institutions issued by the Danish Financial Supervisory Authority. The conditions that have to be present for using the model are based on sector information, development overview and conditions in the coming year s budget. The guidelines in the Danish Financial Supervisory Authority s probability model are used when calculating credit risk. These guidelines are outlined in the Danish Financial Supervisory Authority s guidelines on adequate base capital and solvency requirement for financial institutions. For customers with impairments the unsecured exposure is fully reserved. In addition, the unsecured exposure in rating category 2c is reserved by 50%. Market risk is calculated using the stress factors in the guidelines from the Danish Financial Supervisory Authority on adequate base capital and solvency requirement. The Bank uses the base indicator method for calculating operational risk. As mentioned in the section on operational risk, the solvency requirement for operational risk is DKK 47.9 million, and this is included in the individual solvency requirement. For determining other risks the Bank mainly uses the Danish Financial Supervisory Authority s guidelines for sufficient base capital and individual solvency requirement. Table 5: Individual solvency requirement (DKK 1,000). Risk area Adequate base capital DKK % of weighted items Credit risk 384, % Market risk 155, % Operational risk 47, % Other risk 42, % Total 630, % At the end of 2012, Eik Banki s solvency ratio was 23.3% (DKK 1,170 million) and the individual solvency requirement was 12.54% Counterparty Risk Eik Banki uses the market value method for counterparty risk, when calculating the size of the exposure and risk-weight for derivatives covered by the Executive Order on Capital Adequacy, Appendix 17. Determination of the value of the exposure by using the market value method for counterparty risk is derived from the procedure below: 1. All contracts are computed at market value and all contracts with a positive value are included. 2. The contracts nominal principals or the underlying values are multiplied by percentages fixed by the Danish Financial Supervisory Authority to establish the potential future credit exposure. 3. The counterparty exposure value is calculated as the sum of the positive market value and the potential future credit exposures.

9 9 The Bank allocates capital equivalent to 8% of the positive market value of the derivatives. When Eik Banki enters into agreements with a counterparty regarding derivatives, credit limits must be observed. At the end of 2012 the positive fair value of derivatives was DKK 5.5 million. 5 Credit Risk In this section Eik Banki s credit risk is described, including objectives, policy and actual credit risk exposures. 5.1 Objectives and Risk Policies Credit risk is defined as the risk of financial loss arising when customers are unable to meet their financial obligations to Eik Banki. Credit risk is managed according to Eik Banki s Credit Policy and instructions from the Board of Directors to the CEO, which stipulate responsibilities and granting authority. The Bank s current Credit Policy was approved by the Board of Directors on 13 February The Credit Policy is updated, should the Bank wish to change the credit terms in order to take into account external or internal changes that could affect the creditworthiness of specific customer groups. The Credit Policy is reviewed by the Board of Directors annually. The Credit Policy is prepared in accordance with the Danish Financial Business Act and Executive Order No. 336 of 12 April 2012 for the Faroes on the governance and management of financial institutions etc. The Credit Policy determines the basic rules that apply as to how the Bank handles credit risk in relation to the Bank s business organisation, operations and within the framework set by the Danish Financial Supervisory Authority Authority and division of labour It is Eik Banki s policy to provide lending authorities according to competence and needs. The Board of Directors has provided the CEO with granting authorities, which have, in part, been delegated to the Head of Credit. The CEO also delegates lending authorities to the Head of Retail Banking and the Head of Corporate Banking these are to some extent passed on to customer advisers. Eik Banki s credit granting is overseen by the Credit Department, which conducts regular checks to see if the lending authorities are being complied with. The Credit Department is responsible for day-today credit granting. This includes developing credit management tools, such as ratings, drawing up credit granting processes and value assessments of collateral. The Credit Department must also ensure compliance with limits on e.g. customer concentration and industry concentration. The Credit Department is responsible for the Bank s impairment procedures and credit risk management including monitoring the development in overdrafts and arrears. The Credit Department reports to the CEO on developments in the Bank s credit risk and whether the respective branches operate within their lending authorities and comply with the Bank s credit policy. The CEO presents this report to the Board of Directors on a quarterly basis. Customer advisers, together with their Branch Manager, are responsible for daily credit control. Customer advisers monitor the customer portfolios that have been assigned to them. Reports are made on a regular basis to determine whether customers honour their

10 10 obligations and to ensure swift decision making in the event of a customer s negative financial development. The Credit Department supervises the Bank s credit systems and credit granting processes. The Credit Department has higher lending authorities than the individual branches and is therefore involved in the granting of larger credit facilities, as well as more complicated exposures. Credit is granted on the basis of the individual customer s financial situation with regard to ability and attitude to repay the loan, as well as collaterals. As a general rule, credit is not granted solely on the basis of collateral Credit Management and Control Lending authorities have been granted to branch managers and customer advisers according to an assessment of competence and need. Credit applications that exceed these lending authorities must be submitted to the Credit Department, CEO or Board of Directors. Certain conditions should be met in order for credit to be granted. For retail customers such conditions include a sufficient margin for personal disposable income and collaterals. When loans are granted with a variable interest rate, consideration is also made as to whether the borrower is able to repay the loan, should interest rates rise. Furthermore, when considered necessary, the borrower is required to take steps to cover the interest rate risk. Eik Banki monitors the economic development of the loan portfolio. This includes submitting sizeable credit exposures to the Board of Directors for renewal annually. The credit applications must include the customer s financial situation and the conditions for the exposure to be continued by the Bank. The Bank s Credit Department must ensure that the annual renewal is implemented timely and properly, however, the respective branches, where the customer is registered, are responsible for the exposures being renewed on time Credit granted by customer advisers and Branch Managers When credit applications are within the lending authority of the customer adviser, the customer adviser fills in an application in the credit granting system and grants the loan. In cases where the credit application exceeds the customer adviser s lending authority, the customer adviser prepares the application in the credit granting system. The credit application is then reviewed and granted/denied by the Branch Manager. In cases where the application exceeds the Branch Manager s authority, the application is reviewed by the Credit Department and, if necessary, presented to the CEO or Board of Directors Collaterals Credit is granted on the basis of willingness and ability to repay. In addition to this, the Bank wants to limit risk by requiring collaterals. The types of collateral most frequently provided are real estate, ships and personal property. The value of the collateral is estimated using set procedures, thus ensuring uniform estimations. The Bank regularly assesses the value of the collateral provided. The value of the collateral is calculated as the price that would be obtained in a sale Risk concentration In order to ensure a spread in the loan portfolio, the credit policy stipulates that no single exposure, with deduction of certain guaranteed claims and collaterals received, must generally be higher than 10% of the

11 11 Bank s base capital. Additionally, it is the Bank s aim that the total amount of these exposures does not exceed 125% of the base capital. In addition to these limits, the Bank aims for an even distribution between retail and corporate lending and no single industry should account for more than 10% of the Bank s total gross loans Impairments Quarterly assessments are made of the need for impairment charges, in accordance with guidelines from the Danish Financial Supervisory Authority. Impairment charges are based on individual estimations and/or collective estimations. The Bank has assembled requirements for selecting customers to be subject to impairments. The Credit Department is responsible for making impairment evaluations together with the branches. Clear procedures have been adopted for selecting customers and evaluating possible impairments to ensure quality and uniform criteria in the evaluations for all customers. If the Bank establishes an objective indication of negative value adjustment on a loan, an impairment charge is registered. Below is a list of incidents that can trigger an objective indication, which can cause a negative value adjustment: Debtor has encountered serious financial difficulties Breach of contract on the side of debtor, e.g. not making repayments and interest The Bank has relaxed loan conditions due to the debtor experiencing financial difficulties High probability of the debtor going bankrupt or being in need of financial reorganisation Impairment charges are calculated as the difference between the book value of the loan and the present value of calculated future payments. Calculated future payments include income from the potential sale of collaterals. The present value is calculated using the effective interest rate on the loan. Exposures above a certain size are subjected to individual review on a quarterly basis, regardless of the customer s financial situation Rating of customers The Bank uses a rating model to describe the credit quality of individual customers. The rating model is used for credit granting, selection of customers to be reviewed for impairments and conditions for the frequency in single customer follow-ups. The Bank uses the following rating groups: 3 Unconditionally good customers 2a Good customers 2b Average customers 2c Weak exposure 1a and b Exposures with impairment charges 0a Exposure leading to loss. Impairment charge is sufficient 0b Exposure leading to loss and current impairment charge is insufficient Customers The Bank s market segment is Faroese retail, corporate and institutional customers with good repayment abilities Circumstances that are considered when granting credit The Bank considers credit applications based on an assessment of the individual customer s financial

12 12 situation. This assessment must be thoroughly prepared and well documented. Retail customers: Credit granting is based on the customer s personal income and assets, in addition to a calculation of disposable income. Corporate customers: Credit granting is based on the company s revenues, solidity, state of collateral, in addition to the owner s experience and willingness to repay the loan. BRF: Eik Banki collaborates with BRF-Kredit providing mortgage loans for Faroese homeowners. The agreement stipulates that Eik Banki handles all customer communication, conducts customer ratings and forwards loan applications to BRF-Kredit. BRF provides financing for up to 80% of the market value of the properties. Eik Banki guarantees repayment of the loans. 5.2 Actual Credit Risk Exposures This section shows credit risk exposures, riskweighted items and capital requirements as of These are broken down by industry and remaining repayment period. The Bank also analyses non-performing and depreciated assets, transfers on depreciated assets caused by value adjustments and impairment charges, and financial collaterals Risk-weighted exposures and Capital Requirements This section shows risk-weighted items and capital requirements. The table below shows risk-weighted items and capital requirements for credit risk, broken down by exposure groups. Table 6: Risk-weighted exposures in relation to credit risk (DKK 1,000). Exposure group Risk-weighted items Capital req. 8% Central governments or central banks 0 0 Local authorities 0 0 Public entities 23,849 1,908 Financial institutions 63,304 5,064 Retail customers 1 589,578 47,166 Corporate customers 1,854, ,379 Guaranteed by mortgage on real estate 775,756 62,060 Arrears or overdrafts 384,229 30,738 Other exposures, including assets without counterparts 363,921 29,114 Total 4,055, ,430 1 Includes all exposures DKK 3 million. The table below shows risk-weighted items and capital requirements for market risk. Table 7: Risk-weighted exposures in relation to market risk (DKK 1,000). Exposure groups Risk-weighted items Capital req. 8% Bonds 286,223 22,898 Shares 92,951 7,436 Currency risk 70,527 5, Credit Risk and Risk of Dilution The Bank adheres to the Executive Order on Financial Reports for Credit Institutions etc. and uses the

13 13 accounting definition of non-performing and impaired debts as defined in sections Individual impairment charges for all loans are made in accordance with section 52 of the Executive Order on Financial Reports for Credit Institutions etc. Group impairment charges are made in accordance with section 53 of the Executive Order on Financial Reports for Credit Institutions etc.; this applies to loans without individual impairment charges. Total value of the exposures after value adjustments and before considering credit risk decrease was DKK 7,113 million as of The table below shows the exposures after value adjustments before credit risk decrease is analysed. Table 8: Exposures after value adjustment before credit risk decrease (DKK 1,000). Average exposure during Exposure group Exposure after value adjustment the year after value adjustment Governments or central banks 419, ,496 Local authorities 336, ,789 Public entities 120, ,265 Financial institutions 290, ,760 Retail customers 1 896,156 1,114,645 Commercial customers 2,110,366 2,079,192 Exposures secured by mortgage in real estate 2,213,146 2,082,638 Exposures with arrears or overdrafts 304, ,232 Exposures in other items, including assets without counterparties 422, ,524 Total 7,113,030 7,242,542 1 Includes all exposures DKK 3 million. As more than 95% of the Bank s credit exposure is to the Faroese market, the Bank has chosen not to provide information on the geographical spread of the loan portfolio.

14 Table 9: Exposures broken down by industry (DKK 1,000). The table below shows the exposures in accordance to the Executive order on Capital Adequacy, Appendix 3, broken down by industry. The table also shows the breakdown between retail customers and corporate customers. Industries 14 Central governments or central bank Local authorities Public entities Financial institutions Retail customers 1 Commercial customers Exposures secured by mortgage in real estate Exposures with arrears or overdrafts Exposures in other items, including assets without counterparties Total Public authorities 36, , , ,378 1, ,174 Agriculture, hunting, forestry and fishing , ,474 4,721 31, ,636 Industry and raw materials extraction , ,796 7,377 10, ,051 Energy supply , ,262 Building and construction ,764 52,539 13,431 34, ,176 Trade , ,274 29,465 32, ,682 Transport, hotels and restaurants , ,096 4,287 54, ,927 Information and communication ,041 62, ,912 Credit and insurance institutions 382, ,350-35,367 52,955 22, ,183 1,135,083 Real estate , ,257 36,204 12, ,589 Other industries 0 3,050 1, , ,620 31,923 4, ,139 Total corporate 382,505 3,050 1, , ,952 2,100, , , ,183 3,682,458 Retail ,204 8,842 2,062, , ,938,398 Total 419, , , , ,156 2,110,366 2,213, , ,183 7,113,030 1 Includes all exposures DKK 3 million.

15 The table below shows the maturity of credit exposures divided into short and long maturities. Table 10: Credit exposure broken down by maturity (DKK 1,000). 3 months Exposure group On demand 0-3 months 1 year 1-5 years Over 5 years Total Central governments or central banks 373, ,095 24, ,243 Local authorities 73, ,727 38, , ,297 Public entities 1, , , ,951 Financial institutions 271, , , ,350 Retail customers 1 84,928 41,631 20, , , ,156 Commercial customers 245,346 15, , ,443 1,328,394 2,110,366 Exposures secured by mortgage in real estate 8,917 12,637 9, ,770 2,042,270 2,213,146 Exposures with arrears or overdrafts 50,837 4,407 10,145 38, , ,340 Exposures in other items, including assets without counterparties 30, , , ,183 Total 1,140,759 74, , ,770 4,667,881 7,113,030 1 Includes all exposures DKK 3 million. 15

16 5.2.3 Defaulted and depreciated claims This section shows defaulted and depreciated claims. The table below shows exposures that have defaulted and reduce the value of the Bank s claims. The exposures are broken down by industry. The table also shows the breakdown between retail customers and corporate customers. Table 11: Defaulted and depreciated claims broken down by industries (DKK 1,000). Bad debts exposure Depreciated claims exposure End-of-year impairments and provisions Impairments/ provisions ultimo amounts carried to the debit side regarding value adjustments and impairments in the period Public authorities Agriculture, hunting, forestry and fishing 77,851 91,079 57,354 16,762 Industry and raw materials extraction 32, ,664 62,709 15,739 Energy supply ,764 Building and construction 58,311 57,208 29,418 4,095 Trade 45,187 44,674 25,911 5,876 Transport, hotels and restaurants 61, ,846 61,101 12,185 Information and communication ,238 Credit and insurance institutions ,727 Real estate 13,314 34,148 11,541 14,181 Other industries 19,501 48,818 36,72 8,401 Total corporate 308, , ,021 57,986 Retail 160, ,158 61,29 3,203 Total 468, ,86 346,311 61,189 Amounts booked as costs are calculated as: impairments/provisions at end of 2012 less impairments/provisions at start of 2012 including total annual loss. 16

17 The table below shows movements on claims with reduced value caused by value adjustments and impairments. These are divided into individual and group impairments. Table 12: Movements on claims with reduced value caused by value adjustments and impairment charges (DKK 1,000). Individual impairments/provisions Collective impairments Loans Guarantees Loans Accumulated impairments/provisions on loans and guarantees, at the beginning of the year 321,992 2,017 40,031 Impairments/provisions during the year 81,854 1,013 14,528 Reversal of impairments/provisions from previous year, where there is no longer an objective indication of depreciation 28, Other changes 28, ,866 Value adjustment of acquired assets 7,014 0 Impairments, previously individually impaired/set aside for provisions 52, Total impairments/provisions on loans and guarantees at year end 343,811 2,500 57,425 Total impairments on loans and guarantees, where there have been made individual impairments/provisions (calculated before impairments/ provisions) 656,854 5,911 1,773,132 17

18 Financial collateral The table below shows financial collaterals broken down by exposure group. Table 13: Financial collateral (DKK 1,000). Exposure group Collateral with substitution Financial collateral expanded Governments or central banks 0 0 Local authorities 0 0 Public entities Financial institutions 0 0 Retail customers ,120 Commercial customers 3 54,994 Exposures secured by mortgage in real estate 0 0 Exposures with arrears or overdrafts 525 3,675 Exposures in other items, including assets without counterparties 0 0 Total ,192 1 Includes all exposures DKK 3 million. 6 Market Risk Market risk is described below, including objectives, policy and actual market risk exposures. 6.1 Objective and Risk Policy Market risk is defined as the risk that the market value of assets and liabilities, as well as off-balance items, will be affected as a result of changing market conditions. Taking on market risk is an integral part of banking. The market risk in Eik Banki is divided into interest rate risk, equity risk, foreign exchange risk and other price risks. The Board of Directors of Eik Banki has approved a market risk policy, which defines and sets limits for the market risk that the Bank is willing to accept for each market risk area. The Board of Directors and CEO receive regular reports on the market risk and compliance with the limits defined in the policy and instructions from the Board to the CEO Interest Rate Risk Interest rate risk is the risk of loss caused by changes in market rates. Interest rate risk or the modified duration is measured as the expected capital loss, when the interest curve is displaced in parallel by one percentage point up. As a rule, interest rate risk on fixed interest loans is hedged. The largest interest rate risk is in the portfolio of fixed interest rate bonds. This risk is adjusted within certain limits in relation to the interest rate outlook Equity Market Risk Equity market risk is the risk of loss caused by changes in share prices. Equity market risk is managed by managing and monitoring the portfolio of shares closely Foreign Exchange Risk Foreign Exchange risk is the risk of loss caused by fluctuating exchange rates. As a main rule Eik Banki hedges foreign exchange risk. The exception is foreign exchange risk between Danish kroner and Euros, which is only hedged under special circumstances.

19 19 Foreign exchange risk is calculated as the higher figure of foreign exchange assets or debt and is determined as a percentage of the core capital corresponding to the Danish Financial Supervisory Authority s currency indicator Other price risks including Commodity Risk Other price risks is the risk of loss caused by fluctuating market prices on other assets than those mentioned in , e.g. change in commodity prices. At year end 2012 Eik Banki had no other price risks Reporting and Division of Responsibility The market risk policy stipulates the division of responsibility concerning risk taking, monitoring and reporting to the CEO and Board of Directors. The Board of Directors receives reports regularly about the current market risk as compared to the limits defined in the market risk policy and the Board s authorisation to the CEO. The Finance Department is responsible for these reports Responsibility and monitoring Eik Markets has day-to-day responsibility for the Bank s liquidity, securities portfolio and foreign exchange deposits on behalf of the CEO. Thus, Eik Markets is also responsible for ensuring that the market risk is within the limits for market risk that are specified in the instructions from the Board of Directors to the CEO. This is conducted by regularly calculating the interest rate risk on the Bank s bond portfolio, a weekly statement on the currency positions and continuous monitoring of the Bank s equity portfolio. These calculations and statements are then compared to the limits for market risk that have been authorised to the CEO and the authorisation provided to Eik Markets in this area. 6.2 Actual Market Risk This section concerns the actual market risk exposures as of These concern risks related to the trading portfolio, exposures in equities etc., which are not connected to the trading portfolio and interest rate risk Risk pertaining to the Trading Portfolio Solvency requirements for the various risks that constitute market risk are detailed in the table below. Table 14: Risk-weighted exposures with market risk (DKK 1,000). Riskweighted items Capital requirement 8% Bonds 286,223 22,898 Shares 92,951 7,436 Currency position 70,527 5, Exposures in equities that are not part of the Trading Portfolio Exposures in equities that are not part of the trading portfolio are listed below: Table 15: Exposures in equities that are not part of the trading portfolio (DKK 1,000). Exposure Operating influence Shares relating to the Bank s suppliers 17,289-1,881 Corporations 21,012 5,902

20 Interest Rate Risk Interest rate risk separated into various items is shown in the table below. Table 16: Interest Rate Risk in and outside the trading portfolio (DKK 1,000). Interest rate risk Interest rate risk on items outside the Trading Portfolio Balance (loans, deposits, receivables/ debt with financial institutions) 47,181 Total outside of trading portfolio 47,181 Interest rate risk broken down by items in the trading portfolio: Securities in balance (incl. spot market) 12,727 Futures, forwards etc. 0 Total in trading portfolio 12,727 Total Interest Rate Risk 59,908 7 Liquidity Risk Liquidity risk is described below, including objectives, policy and actual liquidity risk exposures. 7.1 Objective and Policy Eik Banki s liquidity risk can be defined as the risk that arises from differences in scheduled outgoing and incoming cash flow in the Bank. Eik Banki identifies the following as liquidity risks: Significant increases in funding expenses Lack of funding preventing Eik Banki from maintaining its approved business model Eik Banki being unable to fulfil its payment obligations due to a lack of funding According to the liquidity policy Eik Banki wants to maintain liquidity, which is 50 per cent above the statutory minimum requirement. At year-end 2012 the Bank s excess liquidity was 297 per cent above the statutory minimum requirement Reporting and division of responsibility The liquidity policy determines the division of responsibility regarding risk taking, control and reporting to the CEO and the Board of Directors. The Board of Directors and the CEO receive a monthly statement on the Bank s liquidity situation from the Bank s Finance Department. The statement is prepared in accordance with section 152 in the Danish Financial Business Act, which stipulates that the total liquidity must be at least 10% of the Bank s debt and guarantee obligations and at least 15% of the Bank s total debt, which has a term to maturity less than one month. Moreover, the monthly report contains a statement on liquidity risk. This is determined by conducting a 12 month projection of the liquidity under normal market conditions and a 12 month projection of the liquidity under stressed conditions. The Board of Directors of Eik Banki has approved an overall risk policy for liquidity risk, which stipulates clear requirements for daily liquidity and statement of liquidity risk Responsibility and monitoring Eik Markets has been given day-to-day responsibility of liquidity by the CEO. Eik Markets is also responsible for the daily monitoring of liquidity and liquidity projections. This is done on the basis of known future cash flows.

21 21 8 Operational Risk Operational risk, including objectives, policy and actual operational risks is described below. 8.1 Objectives and Policy Operational risk is defined as the risk arising from inadequate and inefficient internal processes, human errors, IT-failures and external factors. The Board of Directors approves the risk policy for operational risk, decides on procedures and how monitoring and follow-up on the risks is to be organised. These are reviewed annually, latest on 20 December Eik Banki identifies the following as possible operational risks. Financial loss on the basis of: credit, liquidity, security, market and real estate risk advising retail, corporate and public customers operational risks in staff functions and management manual procedures, guidelines and/or quality of these ineffective internal controls insufficient, integration, stability, and usability of IT-systems operational risks of hosted services inadequate insurance insufficient employee competences in relation to diversity of tasks inadequate security in premises Increased risk may also be a result of new services, products as well as influence from outside factors Reporting and division of responsibility The operational policy stipulates procedures, registration and reporting. Employees are responsible for reporting all risk events to their nearest manager and Risk Management. Risk Management registers the events and briefs the CEO monthly, who, in turn, notifies the Board of Directors at the next board meeting. Risk Management is also required to advise internally and inform about risks, in order to ensure that laws and regulations are followed Responsibility and monitoring As stated in Section 3, Risk Management is authorised by the Management to monitor operational risks. The monitoring is conducted in accordance with the functions of the Risk Management entity defined in section 71 of the Danish Financial Business Act and Executive Order No 336 of 12 April 2012 for the Faroes on the governance and management of financial institutions etc. 8.2 Actual Operational Risk Operational risk can be limited but not eliminated. Regular processes are in place to determine if risk that may have a negative impact on Eik Banki appears. The Bank continuously focuses on developing and improving the management of risks, e.g. by strengthening and reviewing procedures and controls, ensuring documentation, controlling changes and registering, reporting and reassessing risk, in order to increase awareness. Eik Banki s IT-systems are hosted by Skandinavisk Data Center (SDC). The Board of Directors has prepared an overall framework in the IT-security policy to ensure the safety of material and sensitive information. The IT-contingency plan supports this procedure and objectives. A risk analysis of all IT-systems is conducted annually in order to determine what business impact the risk has on Eik Banki. This is conducted in accordance with analyses from BIR, Business Impact Assessment from ISF, International Security Forum. A risk assessment was conducted in January 2013, resulting in an estimated risk amounting to DKK 47.9 million.